Rescue of Lakshmi Vilas Bank

 RBI's move to get  Lakshmi Vilas Bank to merge with DBS India removes a huge uncertainty for depositors. They can now breathe more easily. 

Saving small depositors is an important consideration for the regulator in India. The political costs of letting them go to the wall are unaffordable. But a bank rescue also makes good economic sense. A branch with over 560 branches has franchise value. What's the point in liquidating it? You are not going to raise enough to pay depositors and you will be starving borrowers of funds. The issue is a requirement of capital. LVB management tried hard to raise capital but failed- they obviously didn't inspire confidence in investors. The next best thing was to look for buyer with deep pockets. DBS fills the bill.

The good thing is that LVB has not been foisted on a public sector bank. The scapegoat would have been SBI in the normal course but it was obviously not available after having to reckon with Yes Bank. PNB, the other potential scapegoat, is wrestling with its ongoing merger with OBC.

Is the acquisition of LVB by DBS a pointer to the shape of things to come? Do we expect more foreign banks to come in and acquire assets in the Indian banking sector? I doubt very much. If foreign banks are to acquire Indian entities, they will need to have wholly owned subsidiaries (WOS) in India. Only two foreign banks have shown an appetite for such subsidiaries. (DBS is one of them). 

A WOS  is subject to stringent governance requirements, including the requirements that 50 per cent of the directors should be Indian and one-third must be independent directors. Foreign banks may not be comfortable with such requirements. Nor do they have much of an appetite for infusing capital into emerging markets in a big way, given that are grappling with higher capital requirements in their home markets consequent to Basel 3 norms. 

Besides, foreign banks would think hard about organic growth in a market in which both PSBs and private banks have substantial distribution networks. They would be more interested in growing through acquisition of PSBs. That is a no-no at the moment. The government needs to amend the Bank Nationalisation Act to facilitate such acquisitions. Besides, the RBI is wary of the financial stability implications of a large foreign bank presence. The foreign bank policy unveiled in 2013 says:

From financial stability perspective down side risk may arise if the foreign banks, i.e. WOSs of the foreign banks and foreign bank branches together come to dominate the domestic financial system. To address this risk, restrictions would be placed on further entry of new WOSs of foreign banks, when the capital and reserves of the foreign banks (i.e. WOSs and foreign bank branches) in India exceed 20% of the capital and reserves of the banking system. 

The RBI is unlikely to change its stance even though there is a large need for capital. It would be more receptive to acquisitions of PSBs by Indian entities, whether corporate houses or large NBFCs that convert themselves into banks. The timing of the recommendations of the RBI's internal working group on the subject are thus significant.

LVB shareholders are upset that equity is being written of in the proposed merger. At Yes Bank, bond holders had to take some of the hit, so why not in this case? Well, the RBI does not have a consistent policy on this issue, as this piece in BQ shows. One must reckon that the write off at LVB was intended to make the proposal palatable to DBS. 

More in my BQ article, The Lakshmi Vilas Bank Rescue does not mark a trend.